Currency Swaps, the Dollar, and a Tilted Playing Field

Some pretty big news came out on Thursday (9/24/09) regarding a seemingly obscure program to end what were called "currency infusions."

In fact, these are "currency swaps," and you might want to pay attention to them, because of their high degree of correlation with the rise and fall of the dollar. Currency swaps also offer the perfect vehicle for central banks to engage in currency intervention and manipulation, especially if one of the parties (*cough*US*cough) has a massive trade imbalance and lacks sufficient FOREX reserves to use in daily market intervention activities.

WASHINGTON (Reuters) - Major world central banks announced on Thursday that they planned to scale back massive injections of U.S. dollars into their banking systems as financial markets stabilize after a devastating crisis.

The U.S. Federal Reserve said it would begin to scale back short-term cash auctions in early 2010, while the European Central Bank, the Swiss National Bank, and the Bank of England announced they would curtail steps taken to ensure dollar liquidity.

This isn't part of the exit strategy per se," said Chris Rupkey, an economist for Bank of Tokyo/Mitsubishi UFJ in New York. "It just recognizes that banks have less need for liquidity."

The easiest way to understand currency swaps is to think of them as two separate zero-interest loans. For example, let’s say the fed and the ECB arrange a 80 billion euros ($107 billion) swap. The ECB then lends the 80 billion euros to the US, and the US loans $107 billion dollars to the ECB. Later, at an agreed date, the currency swap is reversed: the ECB returns the $107 billion dollars to the fed, and the fed pays back 80 billion euros.

How central banks use currency swaps

Central banks use the foreign currency from swap agreements to prop up their domestic currency by:

A) Providing the foreign currency to domestic financial institutions. (If those institutions were forced to go to the exchange markets for funding, it would drive down the value of the domestic currency.)

B) Using the foreign currency to directly intervene in exchange markets.

Why currency swaps are so popular

Currency swaps allow central banks to borrow foreign currencies without revealing that their country's banking system or currency is in trouble. In other words, since both central banks involved in a currency swap borrow foreign currencies at the same time, it is difficult to tell which central bank needed them the most. It is this lack of transparency which makes currency swaps so attractive to central banks.

In late 2008, the Federal Reserve entered a massive currency swap arrangement with a variety of central banks all over the globe. Here's how the Fed describes that program:

Currency Swaps At the same time it introduced the TAF, the Federal Reserve announced it would extend currency swap lines with the European Central Bank and the Swiss National Bank. The swap lines provide these central banks with dollars, which they can use to supply liquidity to credit markets in their jurisdictions that are based on dollars. In September 2008, the currency swap lines with the ECB and SNB were increased, and new swap lines with other central banks were authorized, including the Bank of Japan, the Bank of England, and the Bank of Canada.

And here's the reason that we might care to track such programs carefully. Note the strong correlation between the currency swap program and the USD index:

Here we might note that the startling run of dollar strength that caught so many investors off guard (but not Goldman Sachs or JP Morgan, it should be noted) began just in front the steep, half-trillion US dollar currency swap operation that began in earnest in fall of 2008.

Note also that the double top in the USD and its subsequent slide all line up nicely with the swaps additions and withdrawals. Correlation is not causation, but this is a pretty cozy relationship, and it possibly explains one of the more unusual periods of dollar strengthening in recent history.

Speaking of cozy relationships, the one between the NY Federal Reserve and big Wall Street institutions stands out, as do the outsized trading returns that quite conveniently repaired more than a few large firms during this same period of time.

I would humbly submit that Goldman Sachs 97% trading win ratio for 2Q09 is perfectly acceptable evidence that the playing field is not level and that, at the very least, we can agree that the appearance of insider trading exists.

Even now Goldman is "struggling" with the PR nightmare of how to explain an "embarrassment" of riches:

For Goldman Sachs CEO Lloyd Blankfein, an embarrassment of riches has turned into embarrassing riches.

Goldman's bonus pool is expected to swell to an estimated $16 billion after what's expected to be another stellar quarter, and Blankfein is struggling to figure out how to pay his employees in a way that keeps them happy while avoiding another round of populist and political outrage like the bank experienced over the summer.

It really is up to the Fed to prove that they did not tip off a few favored struggling big banks (which magically repaired their balance sheets with magnificent winning trading-desk results over this time frame), than it is up to anybody else to prove that they did.

After all, in a supposedly free market economy, it is critical that the appearance, if not the fact, of an even-playing field be maintained.

This next story, which I carefully saved because I thought it provided critically important insights into the cozy relationship between Wall Street and the Federal Reserve, makes it pretty obvious that the free flow of information between the two is not a matter of speculation, but is a matter of normal daily operations:

NEW YORK -- The low-slung cubicles wrap around the ninth floor of a building three blocks from Wall Street, each manned by a young staffer staring at flashing numbers on a flat-screen computer monitor and working the phones to gather the latest chatter from financial markets around the world.

It could be any investment bank or hedge fund. Instead, it is the markets group of the Federal Reserve Bank of New York, which has been on the front lines of the government's response to the financial crisis. Federal Reserve and Treasury Department officials make the major decisions, but the New York Fed executes them.

The information gathered there provides crucial insights into the financial world for top policymakers. But the bank is so close to Wall Street -- physically, culturally and intellectually -- that some economic experts worry that the New York Fed puts the interests of the financial industry ahead of those of ordinary Americans.

"The New York Fed sticks out as being not just very, very close to Wall Street, but to the most powerful people on Wall Street," said Simon Johnson, an economist at MIT. "I worry that they pay too much deference to the expertise and presumed wisdom of a sector that screwed up massively."

Even some former insiders at the Fed say the bank does not pay enough attention to the fundamental flaws in the country's financial system or to the risks associated with bailing out financial firms -- for instance, the chance that banks will be encouraged to take more unwise gambles. These experts worry that the New York Fed has adopted the mindset of a trading floor: well attuned to ripples in financial markets but not to long-term trends and dangers.

Last month, for instance, Wall Street bond traders wanted the central bank to ramp up its purchase of Treasury bonds, which would help the traders by driving up prices. But Fed officials in Washington and around the country concluded that such a move would be counterproductive in the longer run, in contrast to some New York Fed staffers, whose views more closely mirrored those on Wall Street.

New York Fed employees "play a very valuable role, day in, day out, with detailed contacts with the big financial firms," said William Poole, a former president of the Federal Reserve Bank of St. Louis who is now at the Cato Institute. "What I think is missing is a longer-run perspective. They tend to be sort of short-term in their outlook, which is true of a lot of the financial firms. Traders have a horizon of a few hours or a few weeks, at most."

Conclusion

The announcement of the unwinding of the dollar swaps seems largely to be a matter of announcing something that is already mostly over. More than 90% of the program has already been unwound, and there is only roughly $50 billion left to go.

Noting the tight correlation between the dollar index and the dollar swaps, anybody with insider information to these programs would have been ideally situated to thoroughly clean out the other market traders, who were in the dark as to the timing and magnitude of the program. It could merely be coincidence that the very same Wall Street firms with daily contact with the NY Fed staff secured outsized gains during this period of time, but it is hard to trust that this was mere coincidence, given all that we've recently learned about Wall Street's inability to control its greed.

Let me not just pick on Wall Street. Steven Friedman, the NY Federal Reserve board head in 2008, somehow could not stop himself from buying shares in Goldman Sachs, even as he was overseeing their dramatic rescue. He resigned over the scandal, but good luck locating much analysis or discussion of this amazing turn of events outside of the blogs.

Because a level playing field is vital to our market structure, it would be an enormous relief to both audit the Fed and secure testimony under oath about whether or not certain large Wall Street banks received information that allowed them to game the trading system in unfair ways.

This is not a small matter. One of the consistent reasons given for why foreigners favor our capital markets with their money is because they are large, liquid, and trusted.

As it turns out, there's no real competitive advantage or barriers to entry in capital markets. There's nothing to prevent any other capital center from taking over New York's functions. There are clever people willing to work hard for paper wealth all over the world, every bit as eager and clever as those in the US.

A vital pillar remaining at the forefront of this particular industry rests on trust. And sometimes trust requires a little transparency, especially if appearances have been compromised.

If the Fed and Wall Street have nothing to hide, then they should welcome an audit and investigation with open arms.

Otherwise, investors all across the globe may come to the unfortunate conclusion that the playing field is tilted.

I'm sorry Doc, I'm having a hard time understanding the function of currency swaps (I understand the corruption part). What does the Fed gain by performing a swap? Wouldn't a swap have a neutral effect on the currency market?

(I'm not being critical of anything here, I'm just trying to understand)

viscerally I agree w HR 1207.....but in the end I think its a mistake becasue its an implicit power grab by the Congress to seize money printing power .... no ink on their hands, but much greater ability to force the Fed's hand in dictating policy.

A currency swap, by itself, is both currency and interest rate neutral.

But the swaps came in because there was a huge need for dollars in foreign banks due to the large amounts of dollar denominated loans and credit derivatives held by foreign banks.

Their sudden need for dollars, if they had to come and obtain them from US markets would have created problems for both the Treasury and the Fed which were trying to simultaneously borrow record amounts AND keep interest rates low. So the swaps were officially used to maintain local dollar liquidity and low interest rates.

As mentioned in the post, currency swaps can also be used to manipulate currency markets. Unofficially they appear to have been used to rig the dollar.

If you go to the link that Dr. Martenson supplied in post #6 and click on 'currency swaps' on the left side of the page, you will see that the latest data they supply is for Sept 23, 2009, where 59,121 times one million dollars are involved in these swaps. To me, that is an appallingly large number, even if it was nearly ten times higher near the end of last year. Given this data, is there any reason to not think that ol' Bucky is doomed? How can they 'swap' this much money without severe consequences? That is nearly $200,000 per Untied States citizen out there now, just tied up in these 'swaps,' as of 9/23/09.

Thanks very much for the info, but there isn't a whole lot an unemployed prole like myself can do about it. Ah, well, ol' Bucky was starting to look a bit like toy money anyway. Especially the big purple 5 on the $5.

emhswm: The Constitution specifically grants the power to regulate the value of money to the (elected) Congress, not the (unelected, private) Federal Reserve Board. HR 1207 would be taking back rightful power.

Of course, I am wary of any sort of concentrated political power, but that is why HR 1207 would be a good thing and why I would even support granting Congress increased powers over monetary policy. The basic reason is that they are subjected to an election.

The problem with the current incarnation of the Fed is that it is not "independent" but rather enjoys a very cozy relationship with Foreign Central banks. In effect, this amounts to dictating international policies behind the scenes, since these individuals have nearly autocratic control over monetary policy. Further, the Fed Chairman can typically stay in their position for many years, spanning many administrations. The Chairman of the Federal Reserve Board is widely considered to be one of the top 3 or 5 (if not the top) most powerful people in the world. Surely, since we can't elect them like a President, we ought to at least know what they are doing?

Finally, as Timothy Geithner (former head of the NY Fed) is eager to tell us - the Fed Reserve was created to deal with all the terrible banking panics in our barbaric past. Isn't this statement prima facie oxymoronic??!! If the past 1-2 years do not constitute a banking panic, I don't know what does! And isn't the Fed more powerful now than ever before? Legal issues aside, just evaluating the actions of the past year, in practical terms: just what can't the Fed do regarding our monetary system??? This is not the hallmark of a republic, but rather, one of totalitarianism. Let's judge the Fed on the "fruit" it bears...

Sorry for the rant, but that is my case for taking the first step to exposing this corruption filled cesspit of central planners.

emhswm, in addition to what Mike said about the foreign banks, the major problem is what they do domestically, the Wall St cartel, the lack of exposure, breeding ground for corruption. the audit is basic common sense in a marketplace, because no legal/accounting exposure in any area of the market breeds criminals. Elliott Spitzer explains it well...

Davos, Bernanke seems particularly nervous and uncomfortable answering those series of questions - forgetting some information he knows rather well and also refusing to answer a fair number of the questions with "I don't know" - not a credible response for most of them... His uniform defense is that the actions taken were in the best interest of world markets (as determined by the Federal Reserve board).

It is not just true of international (and national) monetary policy that decisions are made by unelected individuals or groups - the same holds true for much of our foreign policy. Congress is accused of interferring with sensible policy, or meddling, when it tries to have a voice. A few powerful comittee chairs and members make up the lion's share of congressional involvement in such matters - and including defense and national security for that matter. As can be seen from Sibel Edmonds' testimony and interviews just how corrupt and full of hidden agendas these matters are.

I don't expect congressional action on any of these matters to be effective by itself.

And thus, the reason I'm no longer in the US Equity markets any longer. IMO, it would be like giving money to a drug dealer to increase their inventory, knowing they're selling to school children and then coming back handing you a wad of cash and saying "here's your part of the profit". I don't know of any way one can play in the market in which a market "player" doesn't get paid in some way.

A) Providing the foreign currency to domestic financial institutions. (If those institutions were forced to go to the exchange markets for funding, it would drive down the value of the domestic currency.)

then extending $ swaps should decrease the value of the Dollar.

Because foreign gov. take the $ and give it to local banks and at the same time the Fed holds the other currency, which means more dollars will flow worldwide i.e. weaker dollar ... low DXY ??

may be there is one more thing to the puzzle.. AFAIR there was a very good graph on zerohedge that show very good correlation between the current stock market rally and the 300B monetizing by the Fed (they have 10B left).

So my thinking that main reason for the drop in the dollar is this monetizing. May be it is in some way interwinded with the swaps.

And also the point (B) says that they may use the money to manipulate Forex !! May be Chris may extrapolate abit.

One additional fact is also (I think I read it on Karl Denninger site) that just before the crisis of 2008, the Fed withdrew around 100B $. (and probably caused the crash!?), so it has to be in the timeframe before the $ jumped.

Speculation what happens if they withdraw 100B and then make a swap for 100B ?

interesting story but in my opinion you have got the causality backwards. The swaps were put in place becuase of the USD strength, they didn't create the strength in the USD. There was a massive short squeeze in the USD during last autumn whereby European banks were playing the famous carry trade (much like right now) that had to be unwound very quickly. Banks all over the world were scrambling to get hold of USD, therefore the FED arranged these swap lines to facilitate enough USD for European banks.

In effect, the FED actually tried to offset the strength in the USD through these swap lines, not the opposite. And of course the mad scramble by the banks to get USD pushed the Libor through the stratosphere......which was another reason for these swaps.

By the way, I was reading your report "the five horsemen" and I agree with you until no. 4;

I can't see why the USD would lose its value now, after the credit bubble has imploded. The USD has already lost most of its value in the last century through the rapid credit and monetary expansion. Now that the money supply and credit is shrinking, this will increase the dollars value. Deflation is coming, not inflation. The only way that the USD would fall in value if if the FED would through its actions would be able to re-ignite credit growth, but as you can see by the rapidly contracting money supply and credit, they are failing despite the 1.2tr QE program.

The only thing that disturbs me (in my belief of a stronger USD) is the rapid expasion of government debt but I think this problem will solve itself, the public outrage (elections in 2010 wiil be an exellent outlet for this) and probably eventually rising interest rates will reverse this course.

I can't see why the USD would lose its value now, after the credit bubble has imploded. The USD has already lost most of its value in the last century through the rapid credit and monetary expansion. Now that the money supply and credit is shrinking, this will increase the dollars value. Deflation is coming, not inflation. The only way that the USD would fall in value if if the FED would through its actions would be able to re-ignite credit growth, but as you can see by the rapidly contracting money supply and credit, they are failing despite the 1.2tr QE program.

The only thing that disturbs me (in my belief of a stronger USD) is the rapid expasion of government debt but I think this problem will solve itself, the public outrage (elections in 2010 wiil be an exellent outlet for this) and probably eventually rising interest rates will reverse this course.

Hello PistolPete: I'd be interested in hearing CM's views. My own are in-line with what you are saying BUT and it is a big BUT, our federal debt and obligations AREN'T being destroyed. They aren't payable. We take in 2 trillion and p away 4 trillion, a LOT of that 2 trillion isn't being borrowed in the bond market it is being printed. That 2 trillion is ready to go up. If it wasn't for this BUT I'd be a "deflation" camper. I think what will happen is that where credit is destroyed there will be asset prices that tank up until the dollar becomes toast.

I also feel that we are not alone. I think the slide of almost every currency is masking the severity of this.

While crude and elementary and not precise: the gold to what you can buy from now back to 2002 is for me a barometer or chart of where we have been and where we are.

Regarding the currency impact of the swaps, you are only looking at it from one direction. To turn your example around, what if the US used it's hoard of swapped Euros to sell into the Forex markets while the Europeans used theirs to provide to institutions that had debts with US dollar claims against them?

In this circumstance, the US dollars are being 'extinguished' in the service of debts, so no increase in USD supply, and no consequent upwards pressure on the dollar.

Meanwhile there are lots of Euros now flooding the market and so the USD would rise, especially against the Euro and that fits the data from that period perfectly.

One way or the other, the correlation between the swaps and the USD index is there, I am only trying to understand why and what it might mean.

At the time of the surprise dollar strengthening, Paulson, et al., were on record saying that the high price of oil wasn't helping anything and they were deeply concerned about deteriorating conditions in the largest banks. A quick move in the dollar would have accomplished much; it would help repair the balance sheets of many a large bank who were happily positioned in long dollar/short commodity trades (against their hated competitors, the hedge funds), drive down the price of oil at a critical time for consumers, keep US interest rates low and demand for US Treasury paper high.

All at a critical time. This is precisely what happened.

While this could have all been a gigantic series of happy, free-market coincidences, I absolutely do not think this is the case.

Remember, in the fall of 2008 things were very close to ripping apart, so from a policy maker's standpoint, anything was justifiable.

Sept. 24 (Bloomberg) -- Bank of England Governor Mervyn King said two British banks got within hours of a liquidity shortfall on Oct. 6, 2008, and the day after as the U.K. financial system came to the brink of collapse.

“Two of our major banks which had had difficulty in obtaining funding could raise money only for one week then only for one day, and then on that Monday and Tuesday it was not possible even for those two banks really to be confident they could get to the end of the day,” the BBC cited King as saying in an interview to be broadcast later today.

Edward Lazear, chairman of George W. Bush’s Council of Economic Advisers at the time, told the program: “We literally thought that we were on the verge of the Great Depression, and looking back I think we probably were.”

King said that allowing the banks to fail would have brought the economy to a halt, the BBC said.

“Individuals would not have had access to the money in that bank,” he was cited as saying. “Their deposits would have been frozen. The accounts would have not been there for salaries to be paid in to, so many people would not have been paid their salary.

“In turn, they wouldn’t have been able to pay bills to businesses so the businesses would have found that their flow of payments would have come to an end,” King said, according to the BBC.

Let me put it another way; under those circumstances described by Mervyn King, what do you propose the odds are that the world's central banks would have allowed free-market forces to operate unhindered?

I say the odds of that are pretty close to zero, so examining the past evidence and data become more of a forensic exercise than a business school case study in free-market behaviors and explanations.

[Note: In October of 2008, based on my "forensic reading" of the markets I was advising people in the strongest of terms to ready themselves for a possible banking holiday. I am somewhat gratified to discover how close to the mark I was, although disturbed by that very same prospect for obvious reasons.

In these sorts of fast-moving, make-up-new-rules-as-we-go, times I happen to believe that an adherence to how markets used to (or are supposed to) work is a liability. We are in uncharted territory. The captain(s) are making it up as they go while keeping a brave face for the crew. My service to my readers and subscribers is to use my ability to decipher the Captain's actions (not words or posturing) and translate those into actionable thoughts and risk mitigation strategies.

This means I regularly spend time trying to think of alternative and quite often uncommon explanations from the mainstream views. There is value in that, at least if my own portfolio and the unsolicited testimonials I receive are any indication.

As always, I relish any opportunity to engage in thoughtful discussions or debate that can help to bring greater focus to a subject or illuminate the future.]

I read a hypothesis on itulip (which seems feasible to me) that even if you are in deflationary environment you can get inflation, even if the money printed&borrowed are not enough to counteract the the deflating amount of money.

If you look at the the whole thing as a credit card, the printed&borrowed money can just be used to pay the monthly charges not the whole debt. Of course this can't go forever but can ignite the inflation. And also future additional printing is just a matter of policy desicion.

(Edit: Oh, it looks like Mike Pilat beat me to the punch here. And as a "student as Jefferson", he did a very good job at that.)

Congress "seizing" the power to print money? I may be a little foggy on my understanding of the US constitution, but I believe that it states that it is the power of Congress to print ("coin") money!

Check out section 8 of the Constitution: http://www.usconstitution.net/const.html#A1Sec8 . A few lines down it says the congress shall have to power "to coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures"

If I recall correctly what experts on the US Constitution have said, the founding fathers intentionally gave Congress the duty of guarding the purse strings of this nation, believing that the goverance of a nation's monetary and fiscal policies was far too important to entrust to any other less democratic institution. In other words, if legislators pursued unwise fiscal and monetary policy, they could simply be voted out.

(Of course, we can digress and talk about how democratic the Congress really is anymore, with the exorbitant costs of running for office, the advantages of incumbency, and the disturbing degree to which it is penetrated by corporate interests. For a brief read on these topics, I recommend Tom Englehart "dispatches" here: http://www.tomdispatch.com/post/175119/arundhati_roy_is_democracy_melting_ http://www.tomdispatch.com/post/175114/andy_kroll_the_washington_influence_machine )

Setting aside "rubber stamp" Congress's well known flaws, what other institution would you have run our nation's printing presses? Yes, it's scary to think about Nancy Pelosi wielding that power, but considering somebody is gonna be doing it, wouldn't you rather know who? You can't vote the Fed's bureaucrats out of office, 'cuz you never voted the damn rascals in in the first place!

While I completely agree with you that Fed, Treasury and other CB's are rigging, or at least intensely try to rig the markets whenever they feel it suits their purposes, I still think you're on the wrong trail re the swaps. Suppose the CB's indeed intended to initiate a dollar spike and tried to do so using swaps, then -assuming they would try to do so as efficiently as possible- logic would dictate their order of action would have been 1) establish the swap 2) have the Fed flood the market with the swapped euros to ignite the dollar 3) have the ECB +withhold+ its swapped dollars from the market to push the dollar even higher. But that doesn't square with the actual chain of events: the swaps were established +after+ the rise in the dollar had started, and the ECB instead of withholding their swapdollars lent those out almost indiscriminately.

Also, it seems to me it's not the dollars that were extinguished by servicing the debt, it's the +debt+ that was extinguished. After those dollars (coming from the ECB) were paid against those dollar debts/interest in Europe, (part of) those debts had been cleared - but the dollars used to do so were still circulating. They didn't disappear at all. (Perhaps they were repatriated to the US in the act of paying off debt, but that doesn't make them vanish!)

I fully agree with you the spike was too much of a coincidence and I do think the CB's did start it - but in some other way than through these swaps. I have no theory or insight on how they did start the spike, but I do think they they badly needed the swap to +stop+ the spike. That would make sense in a context when their intended nice 'little spikie' to their own horror kept feeding on itself (or more in particular on the huge short dollar positions at the time) and went for a complete blowout. (Well, that's what you get when you manipulate the markets: unforseen & unintended consequences...). But the absolute last thing the Fed wanted, with the US debt running in trillions, was a +truly+ strong dollar, of course. They had to stop it and the swap would have been instrumental in doing so.

After those dollars (coming from the ECB) were paid against those dollar debts/interest in Europe, (part of) those debts had been cleared - but the dollars used to do so were still circulating. They didn't disappear at all. (Perhaps they were repatriated to the US in the act of paying off debt, but that doesn't make them vanish!)

Hi Walter,

If the dollars were repatriated, would that mean the dollars were not sold into the currency market. If dollars are not sold ino the currency market but euros, yen, etc are, would not the dollar exchange rate strengthen?

Yes those (swap)dollars were definitely sold in the currency market - by the ECB! To parties that needed and indeed used those dollars to pay off dollar debts in Europe. Some of those parties may have been US banks or companies operating in Europe who subsequently repatriated those dollars back to the US - though I'm merely speculating here about that last part: what happened to those dollars after they had payed off those debts no-one knows. My point was that those dollars did +not+ disappear from circulation by/after having been used to pay off debt, as Chris wrote.

Also, it seems to me it's not the dollars that were extinguished by servicing the debt, it's the +debt+ that was extinguished. After those dollars (coming from the ECB) were paid against those dollar debts/interest in Europe, (part of) those debts had been cleared - but the dollars used to do so were still circulating. They didn't disappear at all. (Perhaps they were repatriated to the US in the act of paying off debt, but that doesn't make them vanish!)

Walter, paying off a debt to a bank does make dollars vanish. That's how it works.

If you agree that dollars are created when a credit/debit combination is issued, then you (hopefully) must agree that dollars vanish when the credit/debit combo is extinguished. This is just banking mechanics 101.

Now it's possible that the dollars were not used to extinguish debts, but merely to service them, in which case the dollars most definitely do not disappear. The interest payments flow to the top line of the debt holders.

Perhaps your informaiton is better than mine, but what I read was that USD dollars were needed to pay off debts denominated in dollars.

You are absolutely right and I was wrong. I kind of thought we were talking common sense (i.e. when you pay someone back money you've borrowed, he/she will either keep or spend that money...). But instead, of course, we were talking fractional banking here, which is quite a different ballgame (...unless that someone happens to be a bank, in which case the money does indeed disappear - probably into the same nowhere it originally came from.)

However, I don't think my error in any way impairs the point I was trying to make, which was that the swaps effectively put downward pressure on the dollar, not upward. You wrote:

> In this circumstance, the [swapped, WW] US dollars [in Europe, WW] are being 'extinguished' in the

> service of debts, so no increase in USD supply, and no consequent upwards pressure on the dollar.

> [I suppose, just like Lookma pointed out in an earlier post, you meant 'downward pressure' here? - WW]

But there +was+ an increase in USD supply albeit only temporarily: before those swapped dollars could be extinguished through paying off debts, they first were created by the swaps (=USD supply increase) and then sold by the ECB into the market (=lowering the USD rate). So even though those dollars were subsequently extinguished, in their very short existence they did actually have a downward pressure effect on (the price of) the dollar.

Also, consider the alternative situation in which the swaps would not have taken place. In that case the demand for dollars (in Europe) to pay off those debts would still have been the same, but there would have been +no+ increase in dollar supply (in Europe) - not even temporarily. I.e. the dollar would have become more expensive without those swaps.

Then again, one could also argue that without the swaps the Fed of course could not have sold any swapped euro's in the US (assuming they in fact did do so when the swaps were in place, as you contended) and hence without the swaps there would have been less upward pressure (in the US) on the dollar. However, there was no particular extreme demand for euros in the US at the time, but there was extreme demand for dollars in Euroland - and in fact worldwide. I think it's reasonable to assume that would have resulted in a net demand for dollars, which again would have led to a higher dollar without the swaps in place.

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